NY futures ended the week little changed, as March was down just 2 points to close at 82.63 cents.

Despite some wild swings and heavy volume changing hands, the market closed this holiday-shortened week basically unchanged. Over the last two months the March contract has risen by around 14 cents on a closing basis and 16 cents if we take last Friday’s intra-day high of 84.65 cents into account.

While the market has been facing resistance above 83 cents, the string of eight consecutive higher daily lows tells us that there is still a lot of buying waiting underneath the market. The main feature this week was the record high open interest, which rose to 304,637 contracts or 30.46 million bales as of this morning, surpassing the old mark of 302,683 contracts, which was set nearly ten years ago on March 3, 2008.

We are quite amazed that the trade has been fighting the specs all the way up, at a time when seasonality typically points to a reduction of the trade net short due to fixations and the selling of basis-long positions. Since November 15, open interest in futures has risen by around 80,000 contracts or 8.0 million bales, with March accounting for about a third of the increase. The front month has currently around 169,000 contracts or 16.9 million bales open.

Considering that open interest is still going up, we assume that there hasn’t been a lot of progress made in reducing the large amount of unfixed on-call sales on March, May and July. Due to Monday’s holiday the latest on-call figures will only be available tomorrow afternoon, but we guess that there are still over 4.0 million bales open on March and around 7.0 million bales on May and July combined.

Last Friday’s WASDE report was considered to be slightly bearish, if one chooses to believe the numbers. We still feel that the USDA is showing stocks that don’t exist, mainly in China and India. For whatever it’s worth, our global ending stocks number for 2017/18 is roughly 8.7 million bales less than that of the government, while we have 2.8 million bales fewer ROW ending stocks.

However, even 45.2 million bales in ROW ending stocks should still be plenty of cotton when compared to the 39.2 million bales at the beginning of this season and the 37.2 million bales a year before that. In other words, we don’t see a shortage of cotton as the culprit behind this bull market.

Instead we believe that the unprecedented amount of on-call sales, strong spec buying and some quality issues in parts of the US and India have formed this bullish storm. Once such a bull move is in motion, it is often difficult to stop due to a lack of liquidity on the sell side, since speculators typically follow the trend and only exit after a reversal has been confirmed. The 2008 bull market serves a good example for what can happen in such a situation. Ten years ago, the trade was also in a bearish fundamental mindset, but aggressive spec buying pushed the market higher and then forced the trade into covering shorts. This spiked the market from 69 cents on February 13 to a synthetic high of 117 cents on March 5, only for prices to crash back down to 69 cents by March 20. Then, later that year, the market dropped all the way down to 36 cents as the financial crisis took hold.

So where do we go from here? History doesn’t necessarily repeat itself, but it often rhymes! Like in 2008, the trade is putting up a fight, matching new spec longs step-by-step with additional shorts, which has led to this historic open interest. At this point the trade remains convinced that the futures market is out of line and that it will sooner or later have to correct back down.

We agree that the futures market has detached itself from the cash market, but that doesn’t mean that futures prices can’t go any higher. The problem the trade faces is that it needs to reduce its net short position in current crop due to fixations and sales of basis-long positions (= sell cash cotton and buy futures back). In other words, the trade cannot stay short indefinitely and is therefore not only in a fight against the specs, but in a race against the clock as well.

Spec longs on the other hand have no time constraints and might choose to roll their net long down the calendar. Therefore, if the trade is forced to be a net buyer of futures, but spec longs refuse to sell, then prices move higher in search of willing sellers, which is what has happened so far. In order for specs longs to exit their positions, we either need to see a trend reversal or something else that spooks them into selling. Maybe a large amount of certifications might do the trick, but so far we have seen nothing yet on that front.

Although we are quite certain that the market will eventually crash again before July goes off the board, it is impossible to say from what level, since this short squeeze may have a few more rounds to go with this massive open interest!

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